RBI Shock Erases Best BRIC Gain on $8 Billion Exit: India Credit

With the rate increases, Duvvuri Subbarao, governor of the Reserve Bank of India (RBI), seen here, joins policy makers from the largest emerging markets in reining money-market liquidity to stem currency losses and ensure stability in the financial system. Photographer: Kuni Takahashi/Bloomberg

July 17 (Bloomberg) -- India’s surprise decision to boost
borrowing costs just two months after cutting them has erased
the biggest bond gains among the top four emerging markets,
fueling bets $8 billion in fund outflows will be extended.

The yield on 10-year sovereign notes surged 55 basis points
in the past two days to 8.12 percent, the highest level this
year, after the Reserve Bank of India raised two of its interest
rates by 2 percentage points each on July 15, while keeping its
benchmark repurchase rate unchanged. All three measures were
lowered in May, March and January. The 10-year yield is up seven
basis points in 2013 after reversing earlier declines, compared
with a six basis point increase to 3.65 percent in China.

Global funds trimmed holdings of rupee debt by $8.5 billion
from a record $38.5 billion in May as an 8.6 percent tumble in
the rupee since March hurt returns. Before yesterday’s rout,
Indian bonds were this year’s best performers in local-currency
terms among the BRIC nations, with a 6.2 percent gain that
topped China’s 1.4 percent, Russia’s 1.8 percent and Brazil’s
15.5 percent loss, JPMorgan Chase & Co. data show.

“The confidence of investors has been dwindling because of
global market conditions and India’s weakening domestic
situation,” Walter Rossini, a fund manager in Milan for Aletti
Gestielle Sgr SpA, said in an interview yesterday. “Monetary
policy in India won’t ease in the coming months and therefore
foreign-fund outflows may intensify. The outflows are despite
the efforts of policy makers, which means the undertone is weak
and any further measures may have an insignificant impact.”

Brazil, China

With the rate increases, RBI Governor Duvvuri Subbarao
joins policy makers from the largest emerging markets in reining
money-market liquidity to stem currency losses and ensure
stability in the financial system. Brazil raised its benchmark
rates three times this year and a cash squeeze in China sent
interbank borrowing costs to records last month.

After increasing the bank rate and the marginal standing
facility rate to 10.25 percent from 8.25 percent, the RBI plans
to drain cash from markets by selling 120 billion rupees ($2
billion) of government debt at an open-market auction tomorrow.
In addition, the monetary authority said it will cap its daily
fund injections via repurchase contracts, meant to help lenders
meet shortages, to about 750 billion rupees, compared with a
daily average of 882 billion rupees availed by banks this year.

Inflation, Rates

The central bank last raised any of its rates in October
2011, when inflation was close to 10 percent. The pace of gains
in the benchmark wholesale-price index quickened for the first
time in six months in June to 4.86 percent as a falling rupee
made imports costlier, from a 43-month low of 4.7 percent in
May, official data show.

Cooling inflation in the first five months allowed Subbarao
to cut interest rates by 75 basis points, or 0.75 percentage
point, to counter an economic slowdown. The reductions took the
repo rate to the current level of 7.25 percent. Asia’s third-largest economy expanded 5 percent in the fiscal year ended
March 31, the least in a decade, government data show.

International investors reduced ownership of Indian bonds
in each of the last eight weeks as the U.S. signaled it will
scale back stimulus and amid concern India will tighten policies
to support the rupee. The RBI’s tightening measures may push up
yields further and the South Asian nation may unveil more steps
to stabilize markets, according to Goldman Sachs Group Inc.

Shifting Stance

“The measures constitute a shift in monetary stance from
pause to tightening,” Tushar Poddar, a Mumbai-based economist
at Goldman Sachs, wrote in a research note yesterday. “The
longer end of the yield curve can move up due to the RBI selling
government bonds, while the short end will be negatively
impacted by the quantitative restrictions on the repo window. We
think that other measures, including capital and import
controls, are on the table.”

The yield on 10-year sovereign notes has climbed 101 basis
points from a 44-month low of 7.11 percent reached in May,
widening the spread over similar-dated U.S. Treasuries to 559
basis points, according to data compiled by Bloomberg. An
auction of fixed-income purchase permits to foreigners on June
20 failed to meet targets for the first time since October.

The prospect of rupee losses rekindling inflation has cut
room for monetary easing in India even as Goldman Sachs to
Nomura Holdings Inc. say growth in the $1.9 trillion economy
will miss forecasts this fiscal year.

Inverted Curve

India’s sovereign bond yield curve was the most inverted on
record yesterday after the RBI’s measures, a sign investors
expect more economic weakness. The yield on two-year notes has
jumped 147 basis points since May 31 to 8.79 percent, 67 basis
points more than 10-year debt. In China, securities due in a
decade offer 34 basis points more than two-year ones.

This week’s rate increases by the central bank are meant
only to stabilize the exchange rate and don’t signal a change in
the nation’s pro-growth policies, Finance Minister Palaniappan
Chidambaram told reporters in Jaipur yesterday.

“These measures should not be read as a prelude to any
policy rate changes,” he said. “These measures in no way
affect our commitment to growth. The measures are taken to quell
excessive speculation and stabilize the rupee.”

India’s resolve to support the rupee and the recent
increases in yields make the nation’s bonds more attractive,
according to Pictet Asset Management SA, which manages $30
billion of emerging-market debt.

Buying Opportunity

“The RBI is preparing to take the necessary pain,”
Philippe Petit, a Singapore-based senior investment manager at
Pictet Asset, said in an interview yesterday. “It is preparing
to avoid a situation where the currency gets out of control and
they are putting everything behind themselves. The long end
still looks attractive and it looks like a good buying
opportunity.”

Bond risk in India is climbing. The cost to insure the
bonds of government-controlled State Bank of India, seen as a
proxy for the sovereign, for five years rose 40 basis points in
the past three months to 248, according to data provider CMA,
which is owned by McGraw-Hill Cos. and compiles prices quoted by
dealers in privately negotiated markets.

Standard Chartered Plc cut its government bond portfolio in
India to underweight from neutral after the RBI steps, according
to a research report published yesterday. The overnight
interbank borrowing rate in Mumbai surged as high as 9.25
percent yesterday, compared with an average 6.96 percent in the
past month, according to data compiled by Bloomberg.